If there’s anyone qualified to define the best investment, it’s Warren Buffett. He is the billionaire investor who leads Berkshire Hathaway (NYSE: BRK.A) (NYSE: BRK.B)the $600 billion holding company that owns auto insurance Geico, See’s Candies and many others.
In a 2017 interview, Buffett had this recommendation for investors: “I think that’s the thing that makes the most sense pretty much all the time. … [to] always buy a S&P500 low-cost index fund.” Four years later, Buffett repeated his advice, saying, “I recommend the S&P 500 index fund and have had it for a long, long time to people.”
Own the S&P 500
An S&P 500 index fund owns all or most of the stocks in the benchmark S&P 500 index. The index, by its own definition, represents “leading companies in leading industries.” These top-tier securities must meet strict market capitalization, liquidity and profitability requirements.
You can buy all the stocks in the index individually, but it’s much easier to own an S&P 500 index fund, as Buffett recommends. There are many S&P 500 index funds available, and well-known fund families like Vanguard, Charles SchwabLoyalty, State Streetthe SPDRs of , and BlackRock’s iShares.
The low-cost index fund
Following Buffett’s advice, your best bet is a low-cost fund — or a fund with a low expense ratio. The expense ratio is the percentage of your investment that covers the fund’s operating expenses.
Vanguard S&P 500 ETF (NYSEMKT: VOO), for example, has an expense ratio of 0.03%. This means you pay $3 per year for every $10,000 invested. To be clear, you are not paying this amount directly – there is no line item on your statement. These costs are rolled into the fund’s returns.
A few dollars a year might not seem like a lot, but spending funds reduces your bottom line over time.
Suppose you want to invest $10,000 per year in an index fund for 20 years. Choose the Vanguard fund which charges 0.03% for expenses and the projected future value of your investment is $405,506. This assumes an average market growth rate of 7% per year after inflation.
Alternatively, you can invest the same amount in the Rydex S&P 500 Fund, which has a much higher expense ratio of 2.31%. Your projected balance after 20 years is $320,030, or about $85,000 less. Shocking, right?
The importance of consistency
In addition to the “low cost” advice, there is another essential piece of Buffett’s advice to follow: Invest consistently. He means that literally. Invest what you can every month without fail, no matter what happens in the market.
Constant investment is easier and can be more profitable than timing your trades. It’s easier because you make fewer decisions and you don’t have to worry about what the market will do tomorrow or next week. And it helps your earning potential by producing (on average) a lower cost base, compared to trading only when the market is strong.
Investing simply, the Buffett way
A recurring investment in a low-fee S&P 500 index fund is a simple solution to the complex problem of wealth building. It almost seems too easy. But history shows that consistent investment in major US stocks produces average returns of around 7% per year, after inflation.
At this rate of return, you will double your money approximately every 10 years. Sounds pretty promising, right?
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Charles Schwab is an advertising partner of The Ascent, a Motley Fool company. Catherine Brock has positions in Vanguard S&P 500 ETF. The Motley Fool has positions in and recommends Berkshire Hathaway (B shares) and Vanguard S&P 500 ETF. The Motley Fool recommends Charles Schwab and recommends the following options: $200 long calls in January 2023 on Berkshire Hathaway (B shares), $200 short put options in January 2023 on Berkshire Hathaway (B shares) and short calls of 265 $ in January 2023 on Berkshire Hathaway (B shares). ). The Motley Fool has a disclosure policy.